You are on page 1of 25



Financial System

An institutional framework existing in a country to

enable financial transactions
Three main parts

Financial assets (loans, deposits, bonds, equities, etc.)

Financial institutions (banks, mutual funds, insurance
companies, etc.)
Financial markets (money market, capital market, forex
market, etc.)

Regulation is another aspect of the financial system


Financial assets/instruments

Enable channelising funds from surplus units to

deficit units
There are instruments for savers such as deposits,
equities, mutual fund units, etc.
There are instruments for borrowers such as loans,
overdrafts, etc.
Like businesses, governments too raise funds
through issuing of bonds, Treasury bills, etc.
Instruments like PPF, KVP, etc. are available to
savers who wish to lend money to the government

Financial Institutions

institutions and mechanisms which

Affect generation of savings by the community

Mobilisation of savings
Effective distribution of savings


are banks, insurance companies,

mutual funds- promote/mobilise savings
Individual investors, industrial and trading
companies- borrowers

Financial Markets

Market- for short-term funds (less

than a year)

Organised (Banks)
Unorganised (money lenders, chit funds, etc.)


Market- for long-term funds

Primary Issues Market

Stock Market
Bond Market

Organised Money Market


money market
Bill Market

Treasury bills
Commercial bills


loans (short-term)
Organised money market comprises RBI,
banks (commercial and co-operative)

Purpose of the money market


borrow in the money market to:

Fill the gaps or temporary mismatch of funds

To meet the CRR and SLR mandatory
requirements as stipulated by the central bank
To meet sudden demand for funds arising out of
large outflows (like advance tax payments)


money market serves the role of

equilibrating the short-term liquidity position of
the banks

Call money market (1)


an integral part of the Indian money market

where day-to-day surplus funds (mostly of
banks) are traded.
The loans are of short-term duration (1 to 14
days). Money lent for one day is called call
money; if it exceeds 1 day but is less than 15
days it is called notice money. Money lent for
more than 15 days is term money
The borrowing is exclusively limited to banks,
who are temporarily short of funds.

Call money market (2)

Call loans are generally made on a clean basis- i.e.

no collateral is required
The main function of the call money market is to
redistribute the pool of day-to-day surplus funds of
banks among other banks in temporary deficit of
The call market helps banks economise their cash
and yet improve their liquidity
It is a highly competitive and sensitive market
It acts as a good indicator of the liquidity position

Call Money Market Participants


who can both borrow and lend in the

market RBI (through LAF), banks and
primary dealers
Once upon a time, select financial institutions
viz., IDBI, UTI, Mutual funds were allowed in
the call money market only on the lenders
These were phased out and call money
market is now a pure inter-bank market (since
August 2005)

Developments in Money

Prior to mid-1980s participants depended heavily on

the call money market
The volatile nature of the call money market led to
the activation of the Treasury Bills market to reduce
dependence on call money
Emergence of market repo and collateralised
borrowing and lending obligation (CBLO)

Bill Market

Treasury Bill market- Also called the T-Bill market

These bills are short-term liabilities (91-day, 182-day, 364day) of the Government of India
It is an IOU of the government, a promise to pay the stated
amount after expiry of the stated period from the date of
They are issued at discount to the face value and at the end
of maturity the face value is paid
The rate of discount and the corresponding issue price are
determined at each auction
RBI auctions 91-day T-Bills on a weekly basis, 182-day TBills and 364-day T-Bills on a fortnightly basis on behalf of
the central government

Money Market Instruments (1)


market instruments are those which

have maturity period of less than one year.
The most active part of the money market is
the market for overnight call and term money
between banks and institutions and repo
Call money/repo are very short-term money
market products

Money Market Instruments(2)

Certificates of Deposit
Commercial Paper
Inter-bank participation certificates
Inter-bank term money
Treasury Bills( WILL BE DISCUSSED)
Bill rediscounting
Call/notice/term money
Market Repo

Certificates of Deposit

CDs are short-term borrowings in the form of UPN issued by all

scheduled banks and are freely transferable by endorsement and
Introduced in 1989
Maturity of not less than 7 days and maximum up to a year. FIs
are allowed to issue CDs for a period between 1 year and up to 3
Subject to payment of stamp duty under the Indian Stamp Act,
Issued to individuals, corporations, trusts, funds and associations
They are issued at a discount rate freely determined by the

Commercial Papers

Short-term borrowings by corporates, financial institutions,

primary dealers from the money market
Can be issued in the physical form (Usance Promissory Note) or
demat form
Introduced in 1990
When issued in physical form are negotiable by endorsement
and delivery and hence, highly flexible
Issued subject to minimum of Rs. 5 lacs and in the multiple of
Rs. 5 lacs after that
Maturity is 7 days to 1 year
Unsecured and backed by credit rating of the issuing company
Issued at discount to the face value

Market Repos

Repo (repurchase agreement) instruments enable

collateralised short-term borrowing through the
selling of debt instruments
A security is sold with an agreement to repurchase it
at a pre-determined date and rate
Reverse repo is a mirror image of repo and reflects
the acquisition of a security with a simultaneous
commitment to resell
Average daily turnover of repo transactions (other
than the Reserve Bank) increased from Rs.11,311
crore during April 2001 to Rs. 42,252 crore in June

Collateralised Borrowing and

Lending Obligation (CBLO)

Operationalised as money market instruments by

the CCIL in 2003
Follows an anonymous, order-driven and online
trading system
On the lenders side main participants are mutual
funds, insurance companies.
Major borrowers are nationalised banks, PDs and
non-financial companies
The average daily turnover in the CBLO segment
increased from Rs. 515 crore (2003-04) to Rs. 32,
390 crore (2006-07)


Enables setting up of Asset Management Companies to

acquire NPAs of any bank or FI (SASF, ARCIL are
NPAs are acquired by issuing debentures, bonds or any
other security
As a second creditor can serve notice to the defaulting
borrower to discharge his/her liabilities in 60 days
Failing which the company can take possession of assets,
takeover the management of assets and appoint any
person to manage the secured assets
Borrowers have the right to appeal to the Debts Tribunal
after depositing 75% of the amount claimed by the second

The Indian Capital Market (1)


for long-term capital. Demand comes

from the industrial, service sector and
Supply comes from individuals, corporates,
banks, financial institutions, etc.
Can be classified into:

Gilt-edged market
Industrial securities market (new issues and stock

The Indian Capital Market (2)

Development Financial Institutions

Industrial Finance Corporation of India (IFCI)

State Finance Corporations (SFCs)
Industrial Development Finance Corporation (IDFC)

Financial Intermediaries

Merchant Banks
Mutual Funds
Leasing Companies
Venture Capital Companies

Financial Intermediaries (1)

Mutual Funds- Promote savings and mobilise funds

which are invested in the stock market and bond
Indirect source of finance to companies
Pool funds of savers and invest in the stock
market/bond market
Their instruments at savers end are called units
Offer many types of schemes: growth fund, income
fund, balanced fund
Regulated by SEBI

Financial Intermediaries (2)

Merchant banking- manage and underwrite new

issues, undertake syndication of credit, advise
corporate clients on fund raising
Subject to regulation by SEBI and RBI
SEBI regulates them on issue activity and portfolio
management of their business.
RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial banks
Have to adopt stipulated capital adequacy norms
and abide by a code of conduct


are other financial intermediaries such

as NBFCs, Venture Capital Funds, Hire and
Leasing Companies, etc.
Indias financial system is quite huge and
caters to every kind of demand for funds
Banks are at the core of our financial system
and therefore, there is greater expectation
from them in terms of reaching out to the vast
populace as well as being competitive.